Unfortunately for McKesson, it looks as if the profit margin on these drugs was below that of other products. Here’s what Chairman and CEO John Hammergren said last week:

The segment-adjusted operating margin rate for the quarter was 226 basis points, a decline of 8 basis points versus the prior year. This decline was driven by a higher mix of branded drug sales and an adjusted operating profit contribution from Celesio that was lower than we expected. Excluding the impact of Celesio and the hepatitis C drugs, the segment-adjusted operating margin was 248 basis points, an increase of 14 basis points over the prior year. (source)

In other words: Excluding the sales and costs of Celesio and hepatitis C drugs, McKesson’s operating margin would have been higher by 22 basis points (=2.48% minus 2.26%). His explanation is presumably intended to provide Wall Street with a comparable sales growth figure.

These results echo a pattern disclosed in McKesson’s third calendar quarter results, which contain a much more specific disclosure. Here’s what Hammergren disclosed during McKesson’s October 2014 earnings call:

The segment-adjusted operating margin rate for the quarter was 242 basis points…Excluding the impact of both hepatitis C drugs, segment-adjusted operating margin was approximately 250 basis points for the current quarter. (source)

To break even, McKesson would have had to sell at least $1.5 billion of hepatitis C products in last year’s third calendar quarter. If they had, Hammergren’s statement implies that non–hepatitis C revenues were $42.520 billion and operating profits were $1.063 billion (=2.50% * $42.520 billion).

Total third quarter 2014 U.S. sales of Sovaldi and Olysio were about $2.9 billion. Did McKesson account for more than half of those sales? If not, then it lost money selling its hepatitis C product sales. That would not be cool for cats.

UP THE JUNCTION

Wholesaler profits are being squeezed in three ways:

Higher-than-expected sales of the new drugs. Consider Gilead Sciences’ Sovaldi, the hepatitis C drug approved in December 2013. This product had 2014 global sales of $10.3 billion, exceeding pre-launch consensus forecasts by $8.9 billion, or more than 600%! (source)

Greater-than-expected concentration of dispensing share. The hepatitis C drugs are open distribution products and can therefore be dispensed by any licensed pharmacy. However, commercial payers required patients to use a much smaller set of specialty pharmacies—often the ones owned by a health plan or pharmacy benefit manager. As a result, product sales shifted into the wholesalers’ largest customers with the deepest discounts. For McKesson, these include CVS Health’s Caremark business, UnitedHealthcare’s Optum Rx, and the VA.

No offsetting generic margins. Wholesalers’ usual economic model relies on the blended margins from lower-profit brand-name drugs and higher-profit generic drugs. A pharmacy with a high specialty mix will buy very few generic drugs, so it’s another nail in the heart of the wholesale pricing model.

For hepatitis C drugs, some wholesalers instituted “net pricing” terms, which reduce the discount available to smaller pharmacies. Larger pharmacies with negotiating power have been able to push back against these demands. Is that love?

You may be tempted to view specialty drugs as automatically good for wholesalers. But as this example indicates, they may not always be cool for cats.

8 comments:

It is a reverse Robin Hood in the DSA market. Wholesalers take 10% from emerging brands, while less than 1% from existing large pharma. Perverse system, should be based on the cost of managing the flow of the specific product and not on WAC. When wholesalers can demonstrate value other than giving away margin, they will thrive. PS, no one starving on Post Street.

I think some of the large Specialty pharmacies may have been price protected in 2014 when the wholesalers surprised all the specialty pharmacy's by changing the cost of goods to WAC - 1.0% stating changing market forces.Lesson learned when you negotiate with a wholesaler don't forget to discuss price protection. McKesson was likely unable to lower pricing on large SPand therefore did take a loss.

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